20VC Tom Tunguz on Why Now Is The Best Time To Be Investing and The Effect of Late Stage Valuations on Startups

In this episode of the 20 minutes VC, host Harry Stebbings interviews Tom Tunguz, a partner at Redpoint Ventures, discussing the current state of SaaS and the impact of market dynamics on startup valuations. Tunguz shares his journey from a tech-savvy kid in South America to a prominent venture capitalist, detailing his experience with Google and his transition into VC. He provides insights into the valuation trends across different funding stages, emphasizing that while seed and Series A valuations are experiencing a dip, the most significant drops are in later stages, mirroring public market trends. Tunguz also highlights the importance of technology innovation for go-to-market strategies and the potential of SaaS-enabled marketplaces. Additionally, he touches on his personal brand development through his data-driven blog, which originated from a desire to answer questions he encountered in board meetings. The episode concludes with Tunguz's views on emerging SaaS trends, including machine learning integration and conversational user interfaces.

• Harry Stebbings introduces the official Sasta podcast, a collaboration with Jason Lempkin.
• The podcast targets SaaS enthusiasts and features insights from top SaaS operators and investors.
• The new podcast is available for download on iTunes, and listener feedback is encouraged.
• Matamark is thanked for providing analysis and data for the show.
• Mattermark's search tool is highlighted as a free and valuable resource.
• Guest Tom Tunguz, a partner at Redpoint Ventures, is introduced with a background in SaaS investments.

"Hello and welcome to the 20 minutes VC with your host Harry Stebings and my word do we have exciting news for all fans of SAS today."

This quote opens the podcast, setting the stage for the SaaS-focused content and introducing the host, Harry Stebings.

"Firstly, I'm delighted to say that Jason Lempkin at Sasta and I have teamed up to create the official Sasta podcast, bringing you the latest and greatest from the world's best SaaS operators and investors."

Harry announces the launch of a new SaaS-focused podcast in collaboration with Jason Lempkin.

"And the second fantastic piece of news for all SaaS lovers is related to our guest today."

Harry teases the introduction of the guest, Tom Tunguz, linking his appearance to the podcast's SaaS theme.

• Tom Tunguz shares his international upbringing and early exposure to technology.
• At 17, he worked on creating software for billing at a law firm in South America.
• He started a small company with his father focusing on document management and billing software for law firms.
• Tom's academic background includes studying machine learning with applications in physical systems.
• He desired to understand how to build large-scale production systems and sales processes.
• Tom's professional journey took him from a startup to Google, where he worked with social networks and ads.
• His experience at Google led to a transition into product management, working on solutions for social networks.
• Tom joined Redpoint Ventures eight years prior and has since become an authority in the SaaS landscape.

"I moved around a ton as a kid. And then when I was 17, my love affair with technology started when I was about 17 and my dad sent me to South America to stay with a friend of his."

Tom recounts his early experiences with technology and how it led to his interest in the field.

"I ended up actually starting a small company with my dad that built software for law firms."

Tom describes his entrepreneurial experience with his father, which provided him with a foundation in technology business.

"And then when I left school, I really wanted to know... how you built production scale systems that really could handle huge amounts of data and how companies really sold."

Tom explains his motivation for moving from academia to the tech industry to learn about building scalable systems and sales.

• Tom discusses the impact of declining late-stage SaaS valuations on early-stage companies.
• Seed valuations have dropped from high water marks to more moderate levels.
• Series A valuations for premium SaaS companies have seen a reduction but not as drastic as in public markets.
• The most significant valuation contractions are observed in Series B and later rounds.
• Valuations for later stages are more closely aligned with public company pricing, leading to greater volatility.

"It means relatively little at the series a. I think you'll probably see... Well, first, let's go stage by stage."

Tom begins his analysis by segmenting the impact of valuation changes by funding stage.

"Seat valuations, from what I've seen are falling... And that's a pretty meaningful drop at the series A for SaaS companies."

Tom provides specific observations on how seed and Series A valuations in SaaS have been affected.

"I ran this analysis for SaaS in early 2016. The average series A for like a premium SaaS company was about $10 million. And I suspect that will probably fall to seven or eight on average, and valuations will kind of fall with it."

Tom shares data from his analysis, indicating a downward trend in Series A valuations for SaaS companies.

"At this series a, it's a meaningful drop, but it's not a huge drop. It's nothing like we've seen in the public markets, where we are seeing a lot of contraction or compression is in the b rounds. And later."

Tom contrasts the moderate drop in Series A valuations with the more significant drops seen in public markets and later funding rounds.## Forward Revenue Multiple

• Forward revenue multiple is a valuation method based on projected future revenues.
• In the SaaS market, premium companies would command a 15 times forward multiple in private markets.
• Public market multiples for SaaS companies have dropped from 7.7 to 3.3 times, a 57% decrease.
• Paying a 15 times forward multiple is now nearly four times the public market valuation, which is seen as unsustainable.

"So from 7.7 times multiple to 3.3. So let's compare and contrast. So it used to be like premium companies in the SaaS market would command a 15 times forward multiple."

This quote explains the significant drop in the forward revenue multiple from 7.7 to 3.3 in public markets and contrasts it with the historically higher multiples paid for premium SaaS companies in private markets.

• Venture investors previously accepted paying high multiples for future growth.
• The decrease in public multiples affects the perception of risk and the timeframe for which investors are paying.
• Current investment strategies focus on investing at fair multiples that reflect the public market benchmarks and allow for future success.

"It's not that venture investors are no longer paying for forward growth, it's just that if you're at two x the public multiple, you're probably paying something like twelve to 16 months in the future. But if you're at four x the public multiple, you're probably paying two to three years into the future."

Tom Tunguz explains that venture investors are still paying for future growth, but the benchmark for what is considered a reasonable timeframe to pay into the future has shifted due to changes in public market multiples.

• Despite market devaluation, the philosophy is to continue investing in great companies.
• The goal is not to time the market but to ensure enough capital is provided for companies to reach their next milestones.
• Investments are made with the intent to support the company's success rather than to capitalize on market downturns.

"Our philosophy is really, hey, let's just continue to invest in really great companies, no matter what's happening in the markets."

Tom Tunguz emphasizes the importance of consistent investment in quality companies regardless of market conditions, highlighting a long-term approach to venture investing.

• Great companies often have technology innovations that provide a go-to-market advantage.
• Founders with unique insights and experience in a specific market sector are highly valued.
• Examples include leveraging the mobile App Store for lower customer acquisition costs and using machine learning to improve sales conversations in CRM.

"The first is a technology innovation that translates to go-to-market advantage."

Tom Tunguz discusses the importance of technology innovation in creating a competitive edge in the market as a characteristic of a great company.

• Zenefits experienced rapid growth and high valuations as a unicorn in the SaaS space.
• The company targeted an underserved market segment: healthcare insurance for companies.
• Media scrutiny can magnify a company's imperfections and errors in judgment.

"Zenefits is a media darling, right. It was one of the companies with the fastest growth in valuations probably in the SaaS world, the iconic unicorn."

Tom Tunguz reflects on the rise of Zenefits as a highly valued and fast-growing company in the SaaS market and how media attention can impact the perception of a company's performance.## Regulated Industry Challenges for Zenfitz

• Zenfitz faces magnified challenges due to operating in a regulated industry with consumer protection laws.
• Investigations suggest possible non-compliance with these laws, impacting the company's operations.

The compounding factor is that Zenfitz operates in a regulated industry. There are lots of laws that have to do with consumer protections, and so it's better to operate with respecting those laws. I'm not sure about the internals, but it seems like they might have run afoul of those, or at least their investigations.

This quote emphasizes the importance of compliance with consumer protection laws in regulated industries and suggests Zenfitz may have encountered legal issues, affecting their business.

• Free SaaS-enabled marketplaces have grown in popularity due to their disruptive distribution mechanisms.
• These marketplaces often involve free software for suppliers and buyers, with the marketplace itself generating revenue.
• They offer a cost-effective alternative to traditional inside sales teams, especially in industries that have not been digitally disrupted.

So free SaaS enabled marketplace is when you have, there's a supplier of something who has a piece of software, there's a buyer of something who has a piece of software, and then there's a marketplace in the middle.

This quote defines what a free SaaS-enabled marketplace is and sets the stage for discussing its benefits and impact on distribution.

• Vertical SaaS focuses on specific industry segments, such as healthcare or general contractors.
• Venture investors like Tom Tunguz prefer vertical SaaS companies with winner-take-all dynamics due to the market size constraints.
• The trade-off of a vertical approach is a smaller market slice but highly tailored software solutions.

And so as a venture investor, when we look at vertical SaaS, we really want to find companies that have winner take all dynamics there, because if you choose a vertical approach, the trade off that you're making is you say, I'm going to take a smaller slice of the market, but I'm going to focus my software to totally meet that segment's needs.

Tom Tunguz explains the strategic choice of focusing on vertical SaaS and the importance of finding companies that can dominate their niche market.

• Tom Tunguz's personal brand development was unintentional, stemming from his desire to answer questions effectively in board meetings.
• His approach to content creation is data-driven, aimed at providing insights and frameworks without prescribing specific business strategies.

The blog kind of started because I was sitting in board meetings and people were asking me questions about things and I didn't know the answer.

Tom Tunguz shares the origin of his blog, highlighting the importance of being informed and prepared to contribute valuable insights in professional settings.

• Tom Tunguz produces high-quality, data-heavy content by utilizing early morning hours for writing, leveraging a time with minimal distractions.
• He employs the Minto Pyramid Principle to structure his arguments effectively.

I do sleep. I just wake up early. So it started when my first son was born, and he was getting up at 430. He wanted a bottle at 430. So then I would wake up and I would write.

Tom Tunguz explains his personal routine that allows him to create content consistently, emphasizing the importance of finding a productive time to work.

• Tom Tunguz's idea generation process for his blog and newsletter is not detailed in the transcript.

But they both wanted to know, where do you generate your ideas from and what does the idea creation process look like for you?

This quote raises a question about Tom Tunguz's creative process, which remains unanswered in the provided transcript.## Idea Creation Process

• Content marketing insights are derived from television studio programming strategies.
• Understanding and targeting content based on specific personas is crucial.
• Reflecting on recent learnings in various categories can spark content ideas.
• Listing interesting statements or readings can help generate new perspectives.
• Combining different ideas can lead to innovative content.
• Inspiration for posts can come from resonant articles or research.

"The lesson to take away from the tv networks is they understand each Persona that they're going after. And then they target content for each of those personas."

This quote highlights the importance of knowing the audience and tailoring content to different segments, much like TV networks do for their varied programming throughout the day.

"What have I learned in the last week that is material to sales or marketing or product or fundraising?"

Tom Tunguz explains his approach to content creation, which involves reflecting on recent experiences or knowledge gained in key business areas.

"What have I talked about or read? That's really resonated with me."

Tom Tunguz shares that personal resonance with a topic, such as an article on the future of offices, can be a strong motivator for creating content.

• Speaking instead of typing can significantly increase productivity.
• Using specialized software and hardware can enhance the dictation process.
• Choosing tools that improve over time and reduce noise can aid in clarity and efficiency.

"You can speak three times faster than you can type."

Tom Tunguz emphasizes the efficiency of dictation over typing when it comes to composing emails and blog posts.

"There's this nuance of the product called dragon. That's really good. And it gets better with time."

He endorses Dragon dictation software for its improving accuracy and usefulness over time.

"I use a Sennheiser headset with digital noise cancellation."

The use of a high-quality headset is mentioned as a key component of his productive dictation setup.

• Reading metric-driven content provides valuable insights into industry trends.
• Following authors who post infrequently but offer incisive commentary can be highly informative.
• Appreciating high production value and in-depth analysis in long-form content is important.

"I really like David Scox because he's also really metrics driven."

Tom Tunguz shares his preference for content that is driven by data and metrics, which offers concrete insights.

"Bill Gurley, when he posts. What I like about Bill, he doesn't post very frequently, but he's super incisive."

He values quality over quantity in the content he reads, highlighting Bill Gurley's insightful posts.

"The first round of they, their production value and the consistently high quality, and then the depth of the articles, they've taken a long form pack and I think it's really differentiated."

Tom Tunguz appreciates well-produced, high-quality, and in-depth articles, which he finds distinctive and valuable.

• Machine learning integration in SaaS is a key area of interest.
• Conversational user interfaces, such as chatbots, are seen as the future of software interaction.
• The potential for ecosystems to develop on platforms like Slack is significant.
• Companies that adopt conversational UIs could revolutionize traditional software models.

"One is machine learning in software as a service."

Tom Tunguz identifies machine learning as a transformative technology for enhancing productivity in SaaS applications.

"I really believe that we are going to shift to a user interface that's more conversational with software, chat bots and all that stuff."

He predicts a shift towards conversational interfaces in software, indicating a major change in how users will interact with applications.

"I think there will be an ecosystem built on top of slack, and then I think there will be a handful of companies that take that UI metaphor and become really successful outside of Slack."

Tom Tunguz foresees the development of new business ecosystems around platforms like Slack and the success of companies that leverage conversational UIs beyond Slack.

• Identifying and solving major problems faced by successful companies can guide investment decisions.
• Research and understanding of industry challenges are crucial in the investment process.
• Quick recognition of a company's potential is possible with thorough industry knowledge.

"Let me go invest in that business. And he said, this is the problem."

Tom Tunguz explains his strategy of investing in solutions to problems faced by successful companies like Looker.

"Within the first 5 minutes I knew."

He describes the moment of realization when he recognizes a company's potential, which is informed by his deep understanding of the industry.

• Sharing personal favorites and productivity tips can provide insights into successful habits.
• Discussing recent investments and the rationale behind them offers a glimpse into decision-making processes.
• Expressing excitement about industry trends can inspire others and highlight areas of growth.

"Narcissus and Goldman, my aunt gave it to me. It's about the coming of age story, and it's written by Herman Hess, who brought buddhist philosophies to the west. It's amazing."

Tom Tunguz shares a personal favorite book that has had an impact on him, suggesting the influence of literature on his thinking.

"The most recent public investment is the Dremio business that I mentioned before."

He talks about his most recent investment, Dremio, and explains the strategic thought process behind it.

"Wow. What can I say? What a legend, Tom, such a fantastic and fun interview."

Harry Stebbings closes the interview by expressing admiration for Tom Tunguz's insights and contributions to the industry.